What are the different ways a tastyliver can be long 50 shares of SPY? The simplest thing would be to buy 50 shares of SPY. Others might buy an at-the-money (ATM) call, but we’re option premium sellers so we would sell an ATM naked put. The third choice would be to use a Synthetic Position. How exactly would we put on the synthetic and what are the pros and cons of this choice? A table listed the standard margin for each of the three strategies. The long stock position had the highest margin and the synthetic the lowest. Tom and Tony noted that both the 50 shares and the Synthetic are “Static” and will always be worth 50 shares but the ATM put can move around.
The pros and cons of using a synthetic position were listed. These are things traders should take into account when deciding whether or not to use this alternative. The margin rate is lower than outright stock. Theta decay (time decay) increases our probability of profit (POP). It can easily be done even on hard to borrow stocks. There are downsides. One downside is that a synthetically long position won’t receive a dividend. There is risk of early assignment too. Finally there is exposure to increased Gamma.
Synthetic positions are usually placed ATM and for the same strike but that would create a synthetic position of long 100 shares. When dealing with odd lots (less than 100 shares) we change the strikes. To create a 50 share long we would buy an out-of-the-money (OTM) 25 Delta call and sell an OTM 25 Delta put. A table laid out an example of the synthetic in question with the SPY trading at $206.50. The $211 strike of the long call and the $199 strike of the short put were listed along with the debit for the call and the credit for the put. The total was a 0.55 credit. The breakeven on the downside was also noted at $198.45. A long 50 share position from $206.50 at that same level would be a loss of just over $400.
For more information on Synthetics see:
Closing The Gap from February 6th, 2015: "Synthetic Stock!"
Best Practices from July 27th, 2015: “Synthetic Positions”
Market Measures from September 18th, 2015: “Short Synthetics | Pricing”
Closing the Gap from December 22nd, 2015: “Covered Strangle: Synthetic Underlying”
Closing The Gap from May 16th, 2016: "Covered Strangles: Synthetic Underlying & Strike Selection"
Watch this segment of Best Practices with Tom Sosnoff and Tony Battista for the important takeaways and a better understanding of the pros and cons of Synthetics.
This video and its content are provided solely by tastylive, Inc. (“tastylive”) and are for informational and educational purposes only. tastylive was previously known as tastytrade, Inc. (“tastytrade”). This video and its content were created prior to the legal name change of tastylive. As a result, this video may reference tastytrade, its prior legal name.